Thursday, February 02, 2017

I'll be doing a Darkstream tonight at 7 PM Eastern on the subject of free trade. This is part 1, and it will focus on David Ricardo and the comparative advantage theory that is the primary economic justification for free trade.

UPDATE: The replay is here. For those who want to prepare for Part 2, read Chapter 11 of Economics in One Lesson by Henry Hazlitt.

For those who want to do a little preparation, here is a partial transcript of an interview I did with Ian Fletcher, the author of Free Trade Doesn't Work, which played a major role in my reassessment of free trade.

When most people think of opposition to free trade, they think of three things. They think of the 18th century mercantilists that were supposedly routed by Adam Smith and David Ricardo. They think of the UAW opposing cheap Japanese cars in the 1970s. And they think of Pat Buchanan and his pitchfork populism in the 1988 presidential campaign. How are the arguments you put forward in Free Trade Doesn't Work distinguished from those three things?

You've got to remember that those three examples you gave all consist of people who are, for one reason or another, disreputable in some way and in some currents of opinion but they are also people who did have a point. Mercantilism for example is not just something from the 18th century. It goes back to the very dawn of modern capitalism and the renaissance.

You have to remember that global trade is not something that was invented in 1990. It can go back hundreds of years back to the era when it was conducted with sailing ships. And very shortly after international capitalism began to take shape, various nations and their governments began to learn there were enormous advantages to be derived gaming the system. And surprise, surprise this is still going on it's what China is doing today it's what Japan has done for decades.

To some extent, it's what the United States itself used to do for most of its history. For most of its history the United States was very exclusively a tariff protected economy. The Founding Fathers were protectionists. The economist among the Founding Fathers is Alexander Hamilton, the guy on the ten dollar bill. And he wrote a report entitled "The report on manufacturers" which he submitted to congress in 1791, in which he layed out a rationale for protectionism that still holds good today. Hamilton was a very smart guy. Among other things you might be surprised to learn that he is the inventor of the R&D tax credit, which he proposed in 1791.I had no idea. I knew he was big on central banks. I didn't realize he was up on tax credits as well.

Yeah. The point is that mercantilism is not something that was brought out of the water by Adam Smith who was in many ways, although he was brilliant guy, he was also the servant of various economic interests in his own time, particularly the economic interests of the Scots who had their own quarrels with the English. Adam Smith is not a fully reliable guide in the sense that everything he said was true.

And you mentioned David Ricardo. One of the interesting things about Ricardo is if you actually go back and read his original book in which he enunciated for the first time the theory of comparative advantage, you discover that he says things like well, I have this theory, and one of the provisos to this theory is that if you have international mobility of capital, then my theory that free trade is always your best move ceases to be true.

Joseph Schumpeter is extremely harsh on Ricardo's manner of constructing arguments. He said that Keynes and Ricardo had a lot in common in that way.

There are any number of problems with Ricardo; you have to remember that Ricardo was writing in the early nineteenth century, and his main book came out in 1817. So, to some extent I can forgive him, but the fact that a lot of his reasoning is, by present day standards, exceedingly primitive. Among his other great discoveries was the so-called Iron Law of wages. According to which, you can never help working class peoples, so you might as well not try. There’s a lot in Ricardo to object to if you actually dig into all the economic theories and the constructs that supposedly given to us to prove that free trade is always our best move, under all circumstances. It just isn't true. That's just not what these ideas actually say if you dig into them.

That leads into my next question. You've taken econ 101, and I’ve taken econ 101. Everyone who has is familiar with the theory of comparative advantage. And the example that Ricardo provided using the cloth and wine trade between Portugal and England. But how has it persisted and remained dominant so long, considering that it contains, as you noted, no less than seven dubious assumptions?

The theory of comparative advantage, which basically comes down to the idea that nations trade for the same reason people do. And the reason that you buy your coffee in the coffee shop rather than making it for yourself is not that you can't make it for yourself. It's not even that you might not even be more efficient at making it yourself than the guy in the coffee shop. It's just that you have other things to do with your time.

And to fully elaborate, you can understand why it's advantageous not just to import products, but to import products from nations that are less efficient producers than we are. I mean, we import a huge quantity of goods from China, but China is not a more efficient industrial machine than the United States. In fact, by any of the standard measures they are much less efficient.
Now, the problem with the theory of comparative advantage is that, although it does tell you a lot of good things which are true, and it's a useful analytical construct for dealing with a lot of economic realities, it was never intended by its own inventor and its own intrinsic logic will not support its being turned into a blank check for 100 percent free trade with 100 percent of the world 100 percent of the time. That's just not what the theory actually says. As opposed to what the US Chamber of Commerce and multinational corporations attempting to corrupt the congress with direct and indirect bribery would like you to believe that it says.

But why is it persistent and been so dominant and for so long, considering that not only does it have those seven dubious assumptions, but that it's quite clear that it can't possibly be applied in the manner that it usually is applied?

Because it is advantageous to powerful special interests. That's the main reason. I mean it gives the answer that these guys want to hear, which is that America should practice free trade towards the rest of the world. Which means that multinational corporate interests can produce in China, lay off their American workforce, bring those goods to the United States, and sell them here at an enormous profit which you get when using slave labor. There's no secret.

The subsidiary reason why the theory has remained more popular than it deserves to be is it gratifies the desire of academic economists to have one simple formula that explains the whole world. I mean, if you've dealt with academics. It's a beautiful ivory tower construct because once you master the mathematics of this one simple formula you've got a magic wand that tells you just about everything about international trade without your even needing to consult any empirical facts or statistics on the matter. Let alone actually visit a factory or a dockyard or a shop to see what's really going on.

57 Comments:

There is no decent argument against tariffs that doesn't apply moreso to an income tax. Going off tariffs to an income tax was a serious mistake, if only for the massive auxiliary powers that enforcing an income tax gives a central government.

2. Jehu: "Going off tariffs to an income tax was a serious mistake..."

It's obvious in hindsight that the 16th Amendment was a necessary precursor to the 18th. Prior to the 16th, the US Government was funded primarily by tariffs and excise taxes (which included taxes on substantial amounts of alcohol). Prohibition needed the income tax.

There's been a little research on trade and economic growth since Schumpeter, mostly on increasing returns and path dependence, all of which is a stronger argument against free trade across political boundaries.

It's important to note the political boundaries part of the sentence above, otherwise the criticisms of Ricardo could be applied to inter-divisional transactions inside a firm or transactions between firms in a single city.

The other major assumption made by Ricardo, because it was true in his day, is that trade would be settled in either gold/silver specie or, less likely, banknotes backed by gold. In other words, he assumed a de facto gold standard. The gold standard provided an automatic adjustment to out of balance trade relationships, since if too much gold/silver were drained from a country, it's purchasing power would be reduced and then destroyed...This assumption was explicitly discussed by a famous trade economist in my econ 101 course, as another example of the invisible hand. Once you cut that relationship, as Nixon did by closing the gold window in 1971, huge imbalances can accumulate until ultimately the export nations have to start buying up everything in the trade deficit country just to get rid of the currency.

It's important to note the political boundaries part of the sentence above, otherwise the criticisms of Ricardo could be applied to inter-divisional transactions inside a firm or transactions between firms in a single city.

Some of them can be. But to give one example, the important difference is that the externalities imposed are quantitatively and qualitatively different.

"if you've dealt with academics. It's a beautiful ivory tower construct because once you master the mathematics of this one simple formula you've got a magic wand that tells you just about everything about international trade without your even needing to consult any empirical facts or statistics on the matter."

Considering that about 99.975% of academic economists can list and explain the modern arguments against completely free trade, this isn't an accurate characterization.

(If you can't explain these arguments you can't pass the classroom part of an economics PhD, essential to becoming an academic economist or having a minor in economics for another PhD... in reputable institutions, that is.)

Note that these academics would probably use modern arguments, including endogenous growth theory, increasing returns and path dependence, and political economy, which allow for nuance and measurement.

VD wrote:Some of them can be. But to give one example, the important difference is that the externalities imposed are quantitatively and qualitatively different.

Precisely. But without the modern toolsed, which identifies this (and other) problems, criticism of free trade can be ratcheted up to show that only one system works: central planning of the economy and complete control of the economic agents. (I think it was Groucho Marx that figure this out first, maybe one of his brothers.)

Vox, if you ever have anything to say on Henry George and the land tax/rent tax concepts, I would be very grateful.

I am becoming more convinced that the criticism that profits tend over time to concentrate in the rentier class, coupled with a georgeist analysis of money production, explains a lot about the modern economy. (Effectively, the banks/financial class get to rent us our own money money and thereby absorb an increasing share of profits over time, etc.)

Ricardo was talking under a gold standard where the currency couldn't be manipulated.

Today, if we had that, there would be little gold in the USA having been drained to China and Canada.

The reciprocal inflation/deflation would have created an equilibrium before we were raped.

One of my God Emperor moments was when he said almost a year ago "Currency manipulation". Devaluing your currency 20% creates a 20% export subsidy and 20% import tariff that no one will see.

There are frictional costs to labor mobility (which can be overcome). Normally Portuguese that don't speak English won't migrate to England.

[ref: Sweeny Todd]"Mrs Lovett, do you employ illegal aliens in the manufacture of your Mexican foods?""It depends on what you mean by 'employ' - we have no illegals on our payroll; would you like to sample a taco or burrito?"

Also, would love to hear the nation/country distinction applied here: inter*national* v. inter*country* trade. When trade occurs intranationally (even if it is intercountry), you can rely on a common set of social mores to ensure no one cheats on the commons (i.e. externalities like child labor or north korean prisoner bone dust as a bonding agent) in as much as that particular nation can maintain the mores and punish cheaters.

Looking for some info here. I have yet to get the darkstream to work. I'm using pale moon. Do you have to have a twitter acct to listen in? Or, can gab do the job. Or, none of the above; and, if so, what the heck works.I sometimes feel rather ignorant but willing to learn.Thanks

@13 Within a country, the benefits of successful trade can spill over to other sectors and regions. For example, many people did move from the South to take better jobs in the high-paying factories of the MidWest.

For example, many people did move from the South to take better jobs in the high-paying factories of the MidWest.

Just look at Detroit. ;)

There is obviously a trade off between the benefits of labor mobility and social stability. Family formation is also a tricky one: someone suck with no prospects isn't going to have a family, but forming your family somewhere else doesn't help your nation either (unless you are invading.)

@11. praetorian(Effectively, the banks/financial class get to rent us our own money money and thereby absorb an increasing share of profits over time, etc.)

Are you referring to, in the US as of late, the increasing size of the financial sector as compared to other sectors?

Because that was explained to me as a result of A) insurance megacorporations going wild, B) large "banks" pulling shady stuff, and C) almost every other sector declining far faster than what GDP suggests.

And only because the financial sector is bloating up so much that the GDP looks halfway decent.

I believe something along this topic is covered in his Karl Denniger interview. I'm an economic n00b, but in that interview, he explained the banksters game and it was fascinating to me.

Can I get a link?

My suspicion is that this is more along the lines of the standard libertarian criticism of central banking and less tied to the georgist insight (maybe) that over time profits tend to accumulate in the rentier classes, but applied to finance.

"Comparative Advantage" can be debunked as impractical even if you assume EVERYTHING asserted by its proponents is true: That comparative advantage exists and labor mobility is not a problem:

What happens if you want to do something outside of the "advantageous" industry in your country? What if that "advantageous" industry makes you miserable, or worse, you're not physically fit to work in that field?

So you're supposed to abandon all that you are, your family, your friends, your culture, and move to a completely foreign land?

That really doesn't fly. A healthy society doesn't subsist on just one industry.

Are you referring to, in the US as of late, the increasing size of the financial sector as compared to other sectors?

Yeah, basically the financial system takes over the real economy by renting it something that it generates itself: money ( money being a social convention and therefore a common good.) Insurance is similar, particularly if it is required by government. I'm still working through the concept, but I like that it dovetails naturally w/ distributism. (I got interested in it after reading about it in https://www.amazon.com/gp/product/161017027X/ref=oh_aui_search_detailpage?ie=UTF8&psc=1)

There is a lot more on Georgism (something that has been completely memory-holed, which always makes me interested in it) here:

https://infogalactic.com/info/Georgism

I think there are some interesting ideas in there for folks moving past libertarian analysis into a more nationalist, commons-maintenance perspective.

@7. "Once you cut that relationship, as Nixon did by closing the gold window in 1971, huge imbalances can accumulate until ultimately the export nations have to start buying up everything in the trade deficit country just to get rid of the currency."

Yes, in our case, most of the dollars return to the US in the form of investment into our debt and equity markets, a huge boon to Wall Street (as Fletcher has noted elsewhere). It is a significant part of the bubble-nomics of the last 30 years, and a dynamic that the free trade ideologues seem to be conspicuously silent about.

@19. The banking system in almost every developed country is a cartel that has the special privilege of issuing legal tender credit-money (from nothing) at interest (banks are not simply passive intermediaries as the false Money Multiplier model asserts). See the later chapters of Steve Keen's "Debunking Economics".

Ricardo could be applied to inter-divisional transactions inside a firm

That reminds me about the head of an x-ray department stealing trash bags from the nursing floors so it wouldn't be an expense on her books. She was caught getting them from a limited English cleaning lady who said she gave her rolls of trash bags all the time. She would seek the cleaning lady out on the nursing floors & the cleaning lady thought she was working on the floor. They used them as film covers for infection control. I wonder if she was jewish?

Adam Smith was anti-mercantilist, but he was hardly the enthusiatic proponent of unrestricted international trade that he is often portrayed to be. He supported tariffs under certain circumstances, especially retaliatory tariffs, and those to protect defense industries. And of course, he spent 10 years or so as Commissioner of Customs and Commissioner of the Salt Duties.

Relevant quote from "The Wealth of Nations"“To expect, indeed, that the freedom of trade should ever be entirely restored in Great Britain, is as absurd as to expect that an Oceana or utopia should ever be established in it” (WN IV.ii.43: 471).

Adam Smith was probably a Freemason. Most of his acquaintances were. This is why he cooked up "Free Trade", because this was the Masons way of preparing for globalization. Karl Marx alluded to this when he said, that trade was breaking down barriers and differences. Also Karl Marx alluded to this in his Communist Manifesto when he said Communism will ally itself with other revolutionary movements. What happened is that Communism eclipsed Freemasonry as the weapon of choice for globalization. This is why he advocated what he did.

My suspicion is that this is more along the lines of the standard libertarian criticism of central banking and less tied to the georgist insight (maybe) that over time profits tend to accumulate in the rentier classes, but applied to finance.---

I honestly don't know. I remember it was more about how we are in a fantasy land with magic money that doesn't actually exist.

Is anyone else not seeing the comments on the replays? I watch these on my PC and the last two days comments don't appear when I watch a replay, even on ones where they previously did. Watched tonight's Darkstream live and the comments were there just like before. Just checked the replay and again, no comments. Is this something on my end, or are the comments now not displayed for replays?

After that Darkstream, it really sounds to me like Ricardo's free trade argument is another instance of the ever-popular:

1. I have a desired result.

2. What assumptions can I make to get there?

3. My desired result is proved!

The resulting argument is generally a very tenuous one. Almost all of the counterarguments made in the darkstream are individually, on their own, sufficient to demolish Ricardo's argument.

So, as a sort of question... is there anything to recommend Ricardo's argument? Was it even made honestly? Because that seems like an awfully rickety structure. (Though perhaps it just dates from an era where economics as a whole was little more than some sticks lashed together. If indeed we've progressed much past that.)

I hate to defend economists (since they depress fees for management consulting, those interlopers...), but:

Any good economist will say: there are pros and cons to free trade [and for a reasonable fee -- plus per diem and expenses -- I can shift the balance of evidence in whatever direction the client wants*].

No self-respecting economist would use the Ricardo argument now, particularly because it's so simple it can be understood by anyone. Most likely they'll use some variation of the magic factory example:

"Let's say a new technology that converts corn into cars is discovered and a factory is built in Iowa that can take ~ $20k of corn and convert it into a car that costs $30k to make in Michigan. Can we agree that this technology makes the US richer?

Now, move the factory to Long Beach, CA. Maybe there's a little more cost in moving the corn there, but we're still making the US richer, right?

Now, someone goes into the magic factory and discovers that it's really a depot: stores grain until it's sent to China on bulk carriers and receives cars made in China from RoRos during the night. The effect is the same as the magic factory, so it makes the US richer, right?"

(Remember, this is just the "pro" side. It's very hard to attack directly. But, as every good consultant will tell you, the money is in the "on the other hand part" -- that's what creates afterwork.)

On the other hand, there's about 40 books on my shelf about Industrial Organization, Endogenous Growth, Path Dependence, and one or two about Political Economy (math, not words) that make the "con" case. I've posted a link below to my read of a recent-ish paper by Pisano and Shih that makes the contra case very well.

Here's the simple contra case, with bonus Nazis and commando action:

Germany 1938, Reichsforschungsrat: "since Norway has a comparative advantage in producing heavy water, we don't need to make our own, we'll focus on our comparative advantage of invading Czechoslovakia and Austria and everyone will be better."

Norway 1943: British-trained norwegian commandos blow up the heavy water production facility, then sink a ferry with all the heavy water that had been made (and 1000 or so civilians). Nazis don't get a nuclear device and the Allies win the war.

Moral of the story: comparative advantage and strategic industries don't mix. In unrelated news, where are most of the electronics for the US military manufactured, again? Guangdong or Shanghai?

Not a criticism, these periscopes are off the hook, but I actually really liked it when you were standing. Just saying I liked that intensity. It felt menacing, which was awesome. I'll shut up now. Representing from the Bakken. #MAGA!

@39, comparative advantage works overwhelmingly well in very simple constrained models. The argument is attractive because it's an economic concept that really does work right down to the basic math.... provided you're operating in a simple, constrained model. The textbook examples at the micro level are compelling and interlock with another widely misunderstood concept, opportunity cost.... although with opportunity cost, it's more that it gets ignored than that it gets deified.

So, and this is just my take, the question isn't whether comparative advantage is real; it clearly is, the question is whether it's in the driver's seat. Vox points out several reasons to suspect that it isn't... it might be in the car too, it probably is, but it's not the deciding factor, in Vox's argument.

He goes further to say that when you account for multiple possible overridden assumptions, ie once you're working in the real world, which is a fiendishly complex "model" with no artificial constraints, it simply ceases to be a worthwhile consideration; but remember that in particular, globally liquid capital and globally mobile labour, Vox' two major defeaters of CA, are actually quite new things. It's in the age of internet transactions and cheap international flights that those two of Ricardo's assumptions have gone from "gradually weakening" to "completely irrelevant".

The unwillingness or inability of well-read and smart anarcho-capitalist libertarians to subject free trade to actual analysis rather than offer up the pabulum we've all grown up with used to surprise me. But now they're just ineducables like the rest. Some of them could even be considered cucks. Pity.

What they further seem incapable of understanding is that being against free trade doesn't mean being against all trade.

Tariffs are a matter of horses for courses. For a small economy, they can simply mean an increased cost base for no return. Similar with all other measures. Just because free trade doesn't always work, doesn't mean the opposing view always does, and sometimes free trade has won just because the only other paradigm available at the time had been tried, and was even worse.

VOx says in the 'scope that in some respects he's not presenting an alternative, just a critique of the orthodoxy; and one that it needs.

praetorian wrote:There is obviously a trade off between the benefits of labor mobility and social stability.

Bingo. For me the economic argument is important, but ultimately overridden by the social argument.

Like Vox and many here, I've been a libertarian and free trader. And no doubt like others, I've also had a bit of cognitive dissonance when dealing with the social outcomes of these ideals.

As I've left those ideals behind a bit, in moving to alt-right, I've still wrestled with the economics, but ultimately it doesn't matter because even IF the free trade ideal was true, it's ripping us apart socially. Is it better to be some amount richer but living in a community in tatter with social norms trounced, etc., etc.? No.

Yep, same here exactly. I'm assuming that they just made a change as I could find nothing in the settings, etc. to modify that. On one hand it's OK, as the comments are usually just a distraction to me (and I don't know how Vox pays attention and keeps his line of thought!). But it is a bit weird to not be able to see what he's reacting to (very small deal).

"Fletcher has a cheaper and much shorter book co-authored with William Shearer, with a later publication date, "The Conservative Case Against Free Trade".

Do you know if this gives the basics of the argument in the larger referenced book by Fletcher?"

In this smaller book, he does list the dubious assumptions made by Ricardo's theory. He doesn't unpack of all them, but he does give a few short reasons why some of them are false.

Most of the booklet is focused on history, basically summarizing how protectionism formed a bedrock economic principle of the American republic, from the Founders, thru the origins of the Republican Party, and continuing thru World War 2. There are quotes in favor of protectionism from the likes of George Washington to Calvin Coolidge. The transition to reduced tariffs came in the 1950s, not because we discovered some compelling reason to accept the classical free trade argument, but rather in order to forge a new economic bloc that would prevent certain countries and regions from falling into the Soviet orbit.

He then runs thru the ways that other countries implement "hidden" trade barriers in lieu of tariffs, with the US as one of the few countries that sees fit to "play by the rules" and accept a one-sided system in which trade is only "free" coming into the US, but certainly not "free" going out.

Anticipating the rejoinder that cheaper consumer goods is always and everywhere a better thing for Americans, he then notes that trade policies obviously involve a trade-off between wages and consumer prices, and that - while economic theory says that free trade renders the higher economic surplus of any trade policy, given the simplified nature of the theory, there is no reason in reality to accept that conclusion.

It's a great booklet for a National Review type conservative that has spent years ingesting the classical free trade argument, but has never really looked into a legitimate case for protectionism.

My argument has always been that, even if dealing only with goods and not services, Ricardo assumes full employment, regardless of trade policy. That has demonstrably never been the case. So choice is not actually between an economy with free trade in which everybody is somehow richer, and a smaller one without in which everybody is somehow poorer. It is actually between more profitable economy with less employment, more poverty and social dislocation, and a less profitable economy with higher employment and greater social stability.

Cicatrizatic wrote:National Review type conservative that has spent years ingesting the classical free trade argument, but has never really looked into a legitimate case for protectionism.The NR type knows that his patron's income, and thus his own prosperity, depend on Free Trade(tm). Whether it is good for the nation as a whole is only a secondary consideration. Whether it is good for ordinary Americans is never considered.

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